Derivatives have the following roles:
- Hedging or mitigating the risk in the underlying asset, by entering a derivative contract whose value moves in the opposite direction of its underlying asset position and partially cancels, or this entire risk;
- Creating the possibility option in which the value of the derivative is linked to a specific condition or event (for example, when the underlying asset reaches a specific price);
- Gain exposure to the underlying when it is not possible to exchange for that type of underlying asset (for example, weather derivatives);
- Provide leverage, such that a small movement in the value of the underlying asset can cause a large difference in the value of the derivative;
- Provide indicator:
Prices in the derivatives market focus on expressing the expectations of future market participants and the direction the underlying asset’s price will follow in the future. For example, forward contracts, futures contracts provide important information about the price, which underlies the spot price of a commodity or security.
Prices in forward and futures contracts also include investors’ expectations for future spot prices. It should be noted, however, that this expectation is subject to change. The derivatives market does not provide direct predictions about the future of spot prices, but rather provides useful information about the price movement or risk of the underlying asset.
- Speculate and take a profit if the value of the underlying asset moves in the way one expects (for example, moves in a certain direction, stays inside or outside a specified range, reaches certain level).
- Transfer asset allocations between different asset classes without affecting the underlying assets, as part of transition management.
